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Mohsin Patel 31 May, 21 21 min read

Al Rayan Review (Islamic Mortgage): The Definitive Guide

We have written extensively on Islamic mortgages at IFG (see here, here and here for example and definitely also check out our cool Islamic mortgage comparison tool), but we have previously kept the discussion generic. In this article, for the first time ever, we exhaustively go through Al Rayan’s Home Purchase Plan ( the “HPP”) in particular.

We are confident that nothing as detailed as this has been done for the Al Rayan HPP. In this article we examine the legal, Islamic, commercial and practical aspects of the HPP informed by:

  1. a close read of Al Rayan’s legal documentation;
  2. a wide-ranging survey of Al Rayan customers; and
  3. hundreds of discussions we’ve had with professionals, Al Rayan staff and scholars over the last few years. In short, this has been a time-intensive exercise for us, but inshAllah it is the best resource out there for Muslims wanting to properly understand the Al Rayan mortgage both Islamically and commercially.

Summary

Yes, we’re starting with a summary (there’s nothing worse than trawling through 4,000 words to find a one-paragraph summary tucked away!).

Our conclusion is that, given the current UK context, the HPP is the best Islamic mortgage option out there for those who qualify under the Al Rayan eligibility criteria. However we do have some bones to pick on both the commercial and Islamic side with the HPP as it currently is. We believe the HPP could be better from both a commercial and Islamic perspective if a few tweaks were made to it. We hope this article will help pave the way to making these changes.

From our personal perspectives, Ibrahim has an Al Rayan mortgage, while Mohsin has opted for Heylo Housing (but plans to shift to Al Rayan in the coming years). You should definitely also check our our Islamic mortgage comparison page. It is the only one of its kind in the UK.

 

Islamic & Legal Analysis

What is the structure being used here?

The Al Rayan Islamic mortgage is structured as a Home Purchase Plan. This is a regulatory structure that was specifically created through legislation to assist the Islamic finance industry in being able to provide an Islamic alternative to mainstream mortgages.

For a product to be a legal HPP structure, the bank must hold the buyer’s beneficial interest on trust to be delivered over to the buyer once he has paid off the amount necessary to buy the full interest in the property. At this point the buyer will be transferred over the legal title and will hold complete legal and beneficial interest in the property.

“Hang on, what’s all this beneficial v legal gobbledygook?” you might be saying.

Simply put, a legal owner of a property is the “formal” owner of the property, i.e. the one whose name is on the freehold title at the Land Registry. A beneficial owner is someone who has the right to enjoy or benefit from the property, and this can include the right to any income from the property or to reside in the property.

To complicate matters further, an interest in a house can be a freehold or a leasehold. A leasehold interest is different from a freehold in that it is necessarily time-restricted. A leasehold could be for a few days, or many hundreds of years, but eventually it will expire. When it does expire, the freehold owner will be able to step in and take possession of the property.

The Al Rayan HPP uses a combination of freehold and leasehold to deliver a diminishing musharakah/ijarah model (N.B. that musharakah means “partnership” and “ijarah” means rent). This Islamic finance model goes thus: the buyer of the property slowly buys more and more of the house over time, and his rental payment on the amount he does not own slowly decreases at the same proportion. Eventually he owns the entire house and is no longer paying any rent.

This is a little diagram of how the whole thing works:

So the situation is that the Buyer wants to buy the House, but he doesn’t have enough money to buy outright. But he does have enough for a 25% deposit. So he approaches Al Rayan bank – and this is what happens:

Al Rayan ownership structure post-completion

Al Rayan buys the freehold title in the house at the closing of the transaction, and it is its name that appears on the title. But the buyer gets an equitable interest in the freehold by way of the contract (the DCA – more on that below) and also gets a leasehold for 99 years alongside Al Rayan. This leasehold can only be sold or ended by the consent of Al Rayan, but it does put the buyer on a more secure and long-term footing than a shorter lease would.

Time passes, the Buyer continues paying rent and buying further equity in the House until eventually he owns 100%.

At this point the Bank transfers over the freehold interest in the property to the Buyer, the leasehold ends, and all charges in favour of the Bank are removed from the charges register.

HMRC is thankfully agreeable to only charging Stamp Duty Land Tax (“SDLT”) once, and so SDLT is only payable upon the initial purchase of the house, and not on the final transfer of the freehold by the bank.

Incidentally, this is one area where Al Rayan has an advantage over Heylo.

Which scholars approve and disapprove of the Al Rayan HPP?

Scholar Opinion
Shaykh Haitham Al-Haddad The Al Rayan HPP is not Islamic; it is too much like a debt instrument (i.e. the buyer is locked into purchasing the entire finance amount back from Al Rayan from day one).
Shaykh Akram Nadwi Get a conventional mortgage if necessary, as Islamic finance is just like conventional finance dressed up in a religious garb.
Shaykh Suhaib Hasan (at least in particular cases): get a conventional mortgage if necessary.
Shaykh Abu Eesa The Al Rayan HPP is fine
Sheikh Dr Abdul Sattar Abu Ghuddah The Al Rayan HPP is fine
Sheikh Nizam Muhammed Saleh Yaqoobi The Al Rayan HPP is fine
Mufti Abdul Qadir Barkatulla The Al Rayan HPP is fine
Sheikh Muhammad Taqi Usmani The Al Rayan HPP is fine (though we note he is retired from the Al Rayan Shariah Supervisory Committee)

Are there any issues?

Insurance

An Islamic mortgage necessarily needs to be substantively different from a conventional mortgage. It can’t just be cosmetic changes. We are told that the HPP is substantively different from a conventional mortgage in a number of ways, primary among them the fact that the bank takes on a different set of risks to that taken on by a conventional provider. Let’s take a closer look at some of the key risks at play here. 

No. Risk IFG Commentary Risk borne by
1 House damaged or made defective by an insured risk This liability has been excluded pursuant to clause 9.2(a) of the DCA. Insurer
2 House damaged or made defective by an uninsured risk This liability has been excluded pursuant to clause 9.2(a) of the DCA Buyer
3 Cessation of rent payments if a house gets destroyed/uninhabitable This liability has not been excluded. Al Rayan is on the hook for this Al Rayan
4 Insurance money not being enough to cover damages and/or exceed the maximum finance-to-value ratio The bank has got the right to not rebuild the property but to simply sell the property further to clause 6.1 of the DCA Buyer
5 The buyer doesn't insure the property The bank has got an indemnity from the buyer in clause 7 of the Service Agreement which means the buyer pays Buyer
6 Bank has to get work done to the property and damage is caused by its employees or agents to the property in the process The bank has excluded this liability in clause 12 of the Lease Agreement Buyer
7 The value of the property decreasing Al Rayan simply won’t sell at below market value – or to the extent you would like to, then you need to pay off the remaining amounts due with Al Rayan receiving the acquisition payment they made initially Buyer

As you can see, Al Rayan has effectively hedged the risk in respect of all but one risk (Risk 3). We do not think that Al Rayan needs to be exposed to all of these risks, and we do think that insuring away the risks is an effective and acceptable strategy, but we do make the following recommendations to improve the risk exposure split between parties:

  1. Al Rayan should purchase the insurance for each of its properties. It should purchase a global insurance policy and, if it really wants to, pass on the cost through a slight increase in its global profit margin. But the fact that insurance is used to hedge so much of the bank’s risk, and is also bought by the buyer seems unfair and sends the wrong message to the customer. 

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